Category Archives: Finance

From the Land of D’OH: Timely Payments Make Effective Business

A recent SupplyManagement.com article on how “Direct Payments Will Save Government £40 Million a Year” caught my eye not because improving efficiency in an organization that spends Hundreds of Millions processing paper will, obviously, save Millions, but because of this paragraph:

The government estimates that ensuring SMEs get paid more promptly will enable them to run their businesses more cost-effectively and pass those savings back to the government. It will also improve the cash flow of small businesses and their ability to plan for future deals.

Supply Chain experts and leaders have been preaching this for years. Slow payments force suppliers to take loans, at terms that are significantly worse than what a large buying organization can get. Sometimes, to make payroll and secure cash-flow when buyers take 60, 90, and even 120 days to pay, small/new/perceived-risk supplier organizations have to borrow at 20%, 30%, and even 40% per annum. This substantially drives up their cost of doing business — a cost that will, inevitably, be passed to the buyer with the short-term mindset. If the buying organization pays on time, or, if it needs to, takes out a loan based on its credit terms, which could be only 6%, 5%, or 4%, to pay on time, the supplier can operate more cost effectively and pass on those savings to the buyer. It is that simple.

But this is a government organization. We should be happy they figured it out before Mayan Doomsday and not The Date Heard Around the World [www.isaac-newton.org]. (At least this way some of us will see the beginnings of a government organization coming to its senses during our lifetime.)

Of course, if the UK government really wants savings, it should mandate that the NHS follow this advice. As the world’s fifth largest employer [digg.com], it spends £110 Billion a year and processes Millions of payments. That’s a huge savings opportunity!

“Procurement’s Strategic Role in Driving Total Corporate Performance”


Today’s guest post is from Robert A. Rudzki, President of Greybeard Advisors LLC, who has (co-) authored a number of acclaimed business books, including Beat the Odds: Avoid Corporate Death and Build a Resilient Enterprise, On-Demand Supply Management, and the just published text on Next Level Supply Management Excellence that is a follow up to the now-classic Straight to the Bottom Line.

 

Every CPO or chief supply chain officer needs to be conversant with the performance improvement framework shown in the following figure.

World Class Supply Management

This is one of my favorite charts, and is the essence of relating supply management to improved corporate performance. Let’s walk through this framework briefly — a more involved discussion appears in Chapter 4 of my new co-authored book “Next Level Supply Management Excellence”.

Two important measures of corporate performance are return on invested capital (ROIC) and cash flow. ROIC is calculated by taking the annual earnings of a business and dividing it by the total capital invested in that business (long term debt and stockholder’s equity). ROIC is important because it is an indicator of the current health of a business. For a business to deliver value to its shareholders, ROIC needs to exceed the corporate cost of capital. A company that operates where its ROIC is lower than its cost of capital is essentially liquidating itself.

Improving profits helps to improve both ROIC and cash flow. Reducing the capital intensity of your business also helps to improve ROIC and cash flow. Improving profits while also reducing the capital needed to run the business has a powerful compounding effect on ROIC and cash flow.

So how do we go about improving profits? There are two fundamental ways: revenue enhancements and cost reductions. Supply management can — and should — play an important role in each of those areas, as indicated with examples shown in the Figure above.

Supply management should, for example, take a leadership role in creating a more responsive supply chain, thereby helping the company to win more business (and increase revenues) from customers. Supply management should also take the lead applying good processes to better manage all areas of spend, not just those typically assigned to procurement.

So far so good, but how do we reduce capital intensity? Again, there are two ways: working capital improvements and capital expenditure improvements. Once again, supply management can play an important role in each of those areas. In many companies, for example, there is no clear responsibility for analyzing and coordinating supplier payment terms. This area is ideally suited for supply management to take a lead role (as detailed in Chapter 15 of “Next Level Supply Management Excellence”).

With regard to capital expenditures, experience demonstrates that the sooner Procurement is involved in new projects (even at the concept stage), the better the overall project economics and ramp-up time will be.

A thorough opportunity assessment for supply management requires a careful evaluation of the improvement opportunities in each of the four categories shown on the exhibit. Then, to tie it together for the executive audience, you relate those improvement opportunities to the company’s income statement and balance sheet. Going that extra step allows you to demonstrate the impact of supply management on net income, earnings per share, ROIC and cash flow — all key areas of interest for senior executives. It’s a powerful way to communicate the enormous potential of a transformed supply management organization in the language of senior executives and in a manner relevant to your company.

And, based on our experience, it can pave the way for significant executive support for your agenda.

(Note: Portions of this post are based on the author’s new book “Next Level Supply Management Excellence” — a sequel to the bestselling book “Straight to the Bottom Line“.)


Thanks, Bob.

A Primer on Private Equity for CPOs

Private Equity (PE) investment is on the rise in the EU and the US. However, most of us still don’t know very much about what PE is, how it works, or what Procurement’s role is when dealing with a PE firm. That’s why it was great to see this recent article over on CPO Agenda on “The Final Frontier for CPOs” that tried to create more transparency around the practices and importance of Procurement and Supply Chain in this field.

The first thing to note is that PE groups generally make their money by increasing the value of their portfolio companies while retaining part of the generated value by the time they exit the investment in the company at a higher financial valuation. The acquisition of a portfolio company is financed from funds that are raised from private and institutional investors that give the PE group the task of investing the money, managing the portfolio companies and returning an appropriate profit on the investments.

Given the pivotal role that Procurement and Supply Management have in a company’s competitiveness, product innovation and environmental and social footprint, Procurement and Supply Management serve two important tasks in a corporate context from a PE viewpoint:

  • a strong cash flow contribution to meeting debt obligations under the financing terms in the short term
  • a dedicated and measurable effort to swiftly and sustainably improve EBIT and company valuation in the medium term

Remembering that cash is king in a PE buy-out, cash-flow is crucial. Giving Supply Management’s razor-sharp focus on cost reduction and cost control, Supply Management improves cash-flow that is the vital blood of a PE turn-around. It does this by

  • releasing supply-chain related working capital tied up in unnecessary inventories or unfavourable payment terms
  • achieving like-for-like annual company spend reductions of 3% to 6% though the establishment of price competitive with the most suitable suppliers

Plus, Supply Management’s focus on sustainability helps PE since

  • a lasting and recognizable improvement of the procurement and supply chain capabilities can have a considerable positiveeffect on the sale price of the company
  • the benefits of cost engineering, supplier development and supply chain relocation can be harnessed within the typical investment period of four to five years

And Supply Management can benefit from PE and their support for the establishment of procurement platforms they strive to harness spend synergies (mostly in indirect materials) and best practice across the portfolio companies. In other words, done right, PE and Supply Management can be a win-win relationship.

Risk Mitigation 2012: Economic

In our last post, we covered some potential mitigations for each of the top three geopolitical risks that we identified in our Risk 2011 series. In this post, we are going to cover some potential mitigations for each of the top three economic risks as we continue our series of posts inspired by the World Economic Forum‘s recently released 6th annual Global Risks report, 2011 edition.

03: Asset Price Collapse

Most of an organization’s capital is tied up in two things — its people and its assets. This includes its buildings, its inventory, and the raw materials that will be used to create future inventory. If all of a sudden the value of each of these assets drops 50% over night, the organization loses 50% of the value of these assets — and will likely sustain additional losses when it has to sell its inventory at a deep discount.

While asset price collapses can’t be prevented if a market is flooded, or a market is cornered, or asset prices are artificially inflated by collusion and then drop rapidly when the inflation cannot be maintained, it is often the case that impending asset price collapse can be predicted in advance. Asset prices rise and fall, and they always fall if they get to high. While the exact time, and degree, of collapse cannot always be predicted accurately, it’s often possible to predict an approximate time of collapse, and an approximate degree. If a price collapse is coming, the organization can reduce buys to minimal levels, sell off unnecessary assets in a controlled manner, or, if possible, hold onto them until such time as asset prices return to reasonable levels.

02: Extreme Energy Price Volatility

Today’s organizations are ultimately dependent upon three things – people, raw materials, and the energy required to transform the raw materials into the product the organization will sell. If oil doubles in price, that could make the difference between being able to produce the goods in China and import them into the US for sale at a profit and having to import them into the US for sale at a loss (or risk losing the entire inventory).

Energy price volatility is not going to go away. An organization has two options, try to predict the volatility and ride it out as best as it can, or try to restructure its operations such that it is not (as) dependent on volatile energy sources. There are two ways it can achieve this goal. First of all, it can focus on streamlining its operations to make them as lean as possible. Reducing the energy required is the first step. Secondly, it can invest in creating its own green energy sources to minimize its dependence on external sources. This will go a long way to not only stabilizing its energy costs, but to preventing energy spikes in the future.

01: Fiscal Crisis

The fiscal crisis can lead to many things — currency volatility, a credit crunch, and overall infrastructure fragility. Weakening currencies can cause costs to skyrocket. A credit crunch can severely restrict cash flow and make it almost impossible for an organization to temporarily borrow the cash it needs to secure the inventory required to produce the goods it plans to sell to create revenue and, eventually, generate profit. And infrastructure fragility, which weakens every time there is insufficient cash to invest in necessary maintenance, can result in transportation lanes, power plants, and basic utilities becoming unavailable overnight.

If the organization is a global multi-national, currency volatility can be mitigated by keeping keeping cash in multiple currencies. If a credit crunch is likely, the organization can reduce its expansion and investment plans to maintain enough cash on hand to continue operations without interruption. And if the infrastructure is becoming fragile, the organization can invest in infrastructure improvements. If the government will take loans (by selling bonds) to finance improvements, the organization can invest to insure continued availability of necessary public infrastructure. If not, the organization can invest in its own infrastructure to the greatest extent possible or relocate operations to where the infrastructure is strong and expected to stay strong.

Risk 2011: Economic

In our last post, we discussed the top three geopolitical risks facing your Supply Management organization that were chronicled in the World Economic Forum‘s 6th annual Global Risks report. Chronicling thirty seven types of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. Today, SI is going to continue its coverage of the report by discussing what it believes are the top three risks from an economic perspective.

03: Asset Price Collapse

Most of an organization’s capital is tied up in two things – its people and its assets. This includes its buildings, its inventory, and the raw materials that will be used to create future inventory. If all of a sudden the value of each of these assets drops 50% over night, the organization loses 50% of the value of these assets – and will likely sustain additional losses when it has to sell its inventory at a deep discount.

02: Extreme Energy Price Volatility

Today’s organizations are ultimately dependent upon three things – people, raw materials, and the energy required to transform the raw materials into the product the organization will sell. If oil doubles in price, that could make the difference between being able to produce the goods in China and import them into the US for sale at a profit and having to import them into the US for sale at a loss (or risk losing the entire inventory).

01: Fiscal Crisis

The fiscal crisis can lead to many things – currency volatility, a credit crunch, and overall infrastructure fragility. Weakening currencies can cause costs to skyrocket. A credit crunch can severely restrict cash flow and make it almost impossible for an organization to temporarily borrow the cash it needs to secure the inventory required to produce the goods it plans to sell to create revenue and, eventually, generate profit. And infrastructure fragility, which weakens every time there is insufficient cash to invest in necessary maintenance, can result in transportation lanes, power plants, and basic utilities becoming unavailable overnight. The ramifications of a fiscal crisis can reach far and wide.